The company’s beta is 0.80, the risk free rate is 3.0%, and the market rate of r

Question

The company’s beta is 0.80, the risk free rate is 3.0%, and the market rate of return is 11.5%. Last year’s dividend was $2.35, the current stock price is $88.10, and dividends have been growing at a rate of 5.5% annually. The company pays a rate of 2.25% on its short term debt and 5.75% on its long term debt. The preferred stock dividend paid by the company each year is $1,850,000. The company’s tax rate is 38%. Answer the following questions about the Widget Company.

1. Calculate the capital structure (debt & equity) of the Widget Company.

2. a. What is the after tax cost of accounts payable?

b. What is the after tax cost of short term debt?

c. What is the after tax cost of long term debt?

d. What is the after tax cost of preferred stock?

3. a. Using the Capital Asset Pricing Model (CAPM) calculate the expected rate of return for the stock of The Widget Company.

b. Using the Dividend Growth Model calculate the rate of return for the stock of The Widget Company.

c. What is the rate of return for the stock that you would recommend be used for the Widget Company? Why?

4. Calculate the weighted average cost of capital for the company.

WidgetCoupamy Liabilities & Equity Current liabilites Accounts payable & acouals 66,794 Short term debt 9,322 Total Current Liabilities 76,116 Long Term Debt 176,656 Total Liabilities 252,72 Preferred Stock 25,000 Common Stock 129,396 Total Stockholders Equity 154,305 401168 Total Liabilities & Equity

Explanation / Answer

Beta=0.8
Rf=3%
Rm=11.5%
Cost of Short term debt=2.25%
Cost of long term debt =5.5%
tax rate =38%
cost of prefered stock=1850000/25000000=7.4%

1) debt=176,656,000
Stock=preferd +common=154,396,000
Wt of debt=176,656,000/331,052,000=53.36%
Wt of stock=154,396,000/331,052,000=46.64%

2a)

After tax Cost of Short term debt=2.25%*(1-38%)=1.395%

After tax Cost of long term debt=5.5%*(1-38%)=3.41%

After tax Cost of prefered stock=7.4%

3a)
Ex*(pected return =rf+Beta*(Rm-Rf)
=3+0.8*(11.5-3)
=9.8%

4)Weight of short term debt=9,322,000/331,052,000=0.0282
wt of long term debt=176,656,000/331,052,000=0.5336
wt of prefered stock=25,000,000/331,052,000=0.0755
wt of common stock=129,396,000/331,052,000=0.3627

WACC=(0.0282*1.395%)+(0.5336*3.41%)+(0.0755*7.4%)+(0.3627*9.8%)
=5.972%

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